CHAPTER - 1

INTRODUCTION
Sr. No PARTICULAR PAGE NO

1.1 An Overview of Mutual Fund - Introduction 3

1.2 Meaning and Definition 4

1.3 Structure of Mutual Funds in India 5

1.4 Types of Mutual Fund 7

1.5 History of Mutual Fund 9

1.6 Advantages and Disadvantages of Mutual Funds 15

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1.1 AN OVERVIEW OF MUTUAL FUND- INTRODUCTION:

Now a day’s people are realizing the importance of saving and investing. Saving is a
part of one's income that they put away regularly, it does not necessarily provide
returns and even may not meets short-term needs. But Investing on the other hand,
provides returns and helps us grow our capital, which in turn, will help us fulfilling
our financial goals. An investment is an asset or item acquired with the goal of
generating income. In an economic sense, an investment is the purchase of goods that
are not consumed today but are used in the future to create wealth. In finance, an
investment is a monetary asset purchased with the idea that the asset will provide
income in the future or will later be sold at a higher price for a profit. Investments are
often made indirectly through intermediaries, such as banks, mutual funds, pension
funds, insurance companies, collective investment schemes, and investment clubs.
Though their legal and procedural details differ, an intermediary generally makes an
investment using money from many individuals, each of whom receives a claim on
the intermediary

Today, Mutual Fund has emerged as one of the most popular financial investment
tools. The mutual fund industry is the fast growing segment of the Indian Financial
Market. It provides a variety of schemes which suit the needs and risk return profile of
different categories of investors. Earlier people get scared simply hearing the term
Mutual Fund, but now as there is lots of awareness and realizing the potential of this
asset class, there’s really not much to fear and most definitely a lot to gain by simply
understanding the fundamentals of Mutual Funds. Mutual funds help the small and
medium size investors to participate in today’s complex and modern financial
scenario. Investors can participate in the mutual fund by buying the units of the fund.

Mutual pools the money of people with certain investment goals. The mutual fund is a
type of professionally managed collective investment scheme which pools money
from many investors. The profit gained from investments is shared to unit holders in
proportion to the number of units owned by them. Thus a mutual fund is the most
suitable investment from the common man as it offers the opportunity to invest in a
diversified, professionally managed basket of securities at a relatively cost.

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The mutual fund sectors are one of the fastest growing sectors in Indian economy and
have awesome potential for sustained for future growth. Mutual funds make savings
and investing simple, accessible, and affordable. There is considerable amount of
research being done regarding investment in mutual fund. Through the study it is
examined that the investor having different- different mindset when investing in any
field. So here in mutual fund also the investors having different perspectives related
towards investment in mutual fund that is tax concession, risk diversion, potential
return etc. On the basis of such perception the investor deals in mutual fund to gain
potentially.

1.2 MEANING AND DEFINITION:

What is Mutual Fund?

A Mutual Fund is an investment scheme that collects money from people and invests
those funds in various assets. The money collected from various investors is usually
invested in financial securities like shares and money-market instruments like
certificate of deposit and bonds. Equity, debt and money-market instruments are
broad classifications of asset classes. These investments may be made for the short
term, medium term or long term. The kind of asset invested in also determines the risk
factor of the funds.

DEFINITIONS OF MUTUAL FUND:

According to Bharti V. Pathak,

―A Mutual Fund is a Financial Service Organization that receives money from
shareholders, invests it, earns return on it, attempts to make it grow and agrees to pay
the shareholders. Cash on demand for the current value of his investment‖

According to Chandra Prasanna,

―Mutual Fund is called unit trust or open ended trust – a company that invests the
fund of its subscribers in diversified securities and in turn issues units representing
shares in those holdings. They make continuous offering of new shares at net asset
value and redeem the shares on demand of net asset value determined daily by the
market value of the securities they hold.‖

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According to Jitendra Gala &Ankit Gala (Guide to Indian Mutual Fund),
―Mutual fund is nothing but pooling of money collected from investors by issuing
units to them and is invested in marketable securities according to the investment
objective.‖

According to Indian Institute of Banking & Finance,

―A mutual fund is a type of financial intermediary that pools the funds of investors
who seek the same general investment objective & invests them in number of
different types of financial claims (e.g. equity shares, bonds, money market
instruments)‖

1.3 STRUCTURE OF MUTUAL FUNDS IN INDIA:

In India, the mutual fund industry is highly regulated with a view to imparting
operational transparency and protecting the investor's interest. The structure of a
mutual fund is determined by SEBI regulations. These regulations require a fund to be
established in the form of a trust under the Indian Trust Act, 1882. A mutual fund is
typically externally managed. It is now an operating company with employees in the
traditional sense.
Instead, a fund relies upon third parties that are either affiliated organizations or
independent contractors to carry out its business activities such as investing in
securities. A mutual fund operates through a four-tier structure. The four parties that
are required to be involved are a sponsor, Board of Trustees, an asset management
company and a custodian.
Sponsor: A sponsor is a body corporate who establishes a mutual fund. It may be one
person acting alone or together with another corporate body. Additionally, the sponsor
is expected to contribute at least 40% to the net worth of the AMC. However, if any
person holds 40% or more of the net worth of an AMC, he shall be deemed to be a
sponsor and will be required to fulfil the eligibility criteria specified in the mutual
fund regulation.

Board of Trustees: A mutual fund house must have an independent Board of

Trustees, where two-thirds of the trustees are independent persons who are not
associated with the sponsor in any manner. The Board of Trustees of the trustee

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company holds the property of the mutual fund in trust for the benefit of the unit-
holders. They are responsible for protecting the unit-holder's interest.

Asset Management Company: The role of an AMC is highly significant in the

mutual fund operation. They are the fund managers i.e. they invest investors' money
in various securities (equity, debt and money market instruments) after proper
research of market conditions and the financial performance of individual companies
and specific securities in the effort to meet or beat average market return and analysis.
They also look after the administrative functions of a mutual fund for which they
charge management fee.

Custodian: The mutual fund is required by law to protect their portfolio securities by
placing them with a custodian. Nearly all mutual funds use qualified bank custodians.
Only a registered custodian under the SEBI regulation can act as a custodian to a
mutual fund.

Over the years, with the involvement of the RBI and SEBI, the mutual fund industry
has evolved in a big way giving investors an opportunity to make the most of this
investment avenue. With a proper structure in place, the industry has been able to
cater to more number of investors. With the increase in awareness about mutual funds
several new players have joined the bandwagon.

Mutual Fund Operation Flow Chart:

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1.4 TYPES OF MUTUAL FUND:

There are several other types of funds offered by the asset management companies in
the country. We have segregated the same based on structure, asset class, investment
objective, specialty, and risk, in the sections below.
A. Mutual Funds based on structure:
 Open-Ended Funds: These are funds in which units are open for purchase or
redemption through the year. All purchases/redemption of these fund units are
done at prevailing NAVs.
 Close-Ended Funds: These are funds in which units can be purchased only
during the initial offer period. Units can be redeemed at a specified maturity date.
 Interval Funds: These are funds that have the features of open-ended and close-
ended funds in that they are opened for repurchase of shares at different intervals
during the fund tenure.
B. Mutual Funds based on asset class:
 Equity Funds: These are funds that invest in equity stocks/shares of companies.
These are considered high-risk funds but also tend to provide high returns.
 Debt Funds: These are funds that invest in debt instruments e.g. company
debentures, government bonds and other fixed income assets. They are
considered safe investments and provide fixed returns.
 Money Market Funds: These are funds that invest in liquid instruments e.g. T-
Bills, CPs etc. They are considered safe investments for those looking to park
surplus funds for immediate but moderate returns.
 Balanced or Hybrid Funds: These are funds that invest in a mix of asset classes.
In some cases, the proportion of equity is higher than debt while in others it is the
other way round. Risk and returns are balanced out this way.
C. Mutual Funds based on investment objective:
 Growth funds: Under these schemes, money is invested primarily in equity
stocks with the purpose of providing capital appreciation. They are considered to
be risky funds ideal for investors with a long-term investment timeline.
 Income funds: Under these schemes, money is invested primarily in fixed-
income instruments e.g. bonds, debentures etc. with the purpose of providing
capital protection and regular income to investors.

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 Liquid funds: Under these schemes, money is invested primarily in short-term or
very short-term instruments e.g. T-Bills, CPs etc. with the purpose of providing
liquidity.
 Tax-Saving Funds (ELSS): These are funds that invest primarily in equity
shares. Investments made in these funds qualify for deductions under the Income
Tax Act.
 Capital Protection Funds: These are funds where funds are split between
investment in fixed income instruments and equity markets. This is done to
ensure protection of the principal that has been invested.
 Fixed Maturity Funds: Fixed maturity funds are those in which the assets are
invested in debt and money market instruments where the maturity date is either
the same as that of the fund or earlier than it.
 Pension Funds: Pension funds are mutual funds that are invested in with a really
long term goal in mind. They are primarily meant to provide regular returns
around the time that the investor is ready to retire.
D. Mutual Funds based on specialty:
 Sector Funds: These are funds that invest in a particular sector of the market e.g.
Infrastructure funds invest only in those instruments or companies that relate to
the infrastructure sector.
 Index Funds: These are funds that invest in instruments that represent a
particular index on an exchange so as to mirror the movement and returns of the
index e.g. buying shares representative of the BSE Sensex.
 Fund of funds: These are funds that invest in other mutual funds and returns
depend on the performance of the target fund. These funds can also be referred to
as multi manager funds.
 Emerging market funds: These are funds where investments are made in
developing countries that show good prospects for the future. They do come with
higher risks as a result of the dynamic political and economic situations
prevailing in the country.
 International funds: These are also known as foreign funds and offer
investments in companies located in other parts of the world. These companies
could also be located in emerging economies.

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 Global funds: These are funds where the investment made by the fund can be in
a company in any part of the world. They are different from international/foreign
funds because in global funds, investments can be made even the investor's own
country.
 Real estate funds: These are the funds that invest in companies that operate in
the real estate sectors. These funds can invest in realtors, builders, property
management companies and even in companies providing loans.
 Commodity focused stock funds: These funds don’t invest directly in the
commodities. They invest in companies that are working in the commodities
market, such as mining companies or producers of commodities.
 Market neutral funds: The reason that these funds are called market neutral is
that they don’t invest in the markets directly. They invest in treasury bills, ETFs
and securities and try to target a fixed and steady growth.
 Inverse/leveraged funds: These are funds that operate unlike traditional mutual
funds. The earnings from these funds happen when the markets fall and when
markets do well these funds tend to go into loss.
 Asset allocation funds: The asset allocation fund comes in two variants, the
target date fund and the target allocation funds. In these funds, the portfolio
managers can adjust the allocated assets to achieve results.
 Gilt Funds: Gilt funds are mutual funds where the funds are invested in
government securities for a long term. Since they are invested in government
securities, they are virtually risk free and can be the ideal investment to those who
don’t want to take risks.
 Exchange traded funds: These are funds that are a mix of both open and close
ended mutual funds and are traded on the stock markets. These funds are not
actively managed, they are managed passively and can offer a lot of liquidity.

1.5 HISTORY OF MUTUAL FUND:

The Mutual Fund Industry in World:

Year Century Event

1774 - 1780 18th Unity Creates Strength
1868- 1893 19th Spreading Across Europe
1924- 1934 20th The Start Of “Real” Mutual Funds
1950-1993 21st Modern Times: Index Funds, IRAs & ETFs

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18th Century: Unity creates strength

To know how mutual funds first began, we need to go back to 1774. The idea of
pooling investment capital together in order to own assets was first created in the
Netherlands. Historians credit a Dutch merchant named Abraham van Ketwich with
creating the first ―mutual fund.‖ Ketwich created a diversified pooled security
specifically designed for citizens of modest means. The negotiatie was called
Eendragt Maakt Magt, which translates to "unity creates strength,‖ and owned bonds
issued by foreign governments and plantation loans in the West Indies.
Ketwich followed up the negotiatie with several others, including one that lasted for
more than 114 years before being dissolved. Various other merchants and traders in
the Netherlands began offering similar vehicles to regular folk. In fact, during the
1780s, there were more than 30 negotiaties that owned United States credit issues
alone.

19th Century: Spreading across Europe

By the time the calendar rolled over to the 19th century, Ketwich’s idea had become a
European phenomenon. The negotiatie had spread across almost the entire continent,
especially in England and France. The English offered a few refinements to the
structure and used it to help expand the British Empire. The negotiatie evolved into
the investment trust, which is akin to modern closed-end funds. In 1868, the first
―official‖ investment trust—the Foreign and Colonial Government Trust—was
founded in London. Shares of the fund are still traded on the London Stock Exchange
today.

From here, the investment trust structure flowed towards and into America. Formed in
1893, The Boston Personal Property Trust became America’s first closed-end fund.
Shortly after several others would launch, including the important Alexander Fund.
This fund was critical in shaping the modern history of mutual funds as it allowed
investors to make withdrawals on demand. That feature has many historians calling
the Alexander fund the very first mutual fund.

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20th Century: The Star of Real Mutual Funds

The roaring ’20s saw the introduction of the first official open-ended mutual fund. On
March 21st, 1924, the Massachusetts Investors Trust (MITTX) was created. The key
distinction of this fund was that open-ended mutual funds must buy back their shares
from their investors at the end of every business day. The creation
of MITTX essentially gave birth to mutual fund industry as we know it today.

The late ’20s saw a flurry of mutual fund activity including some notable firsts. State
Street launched its first fund, while Scudder, Stevens and Clark would launch the first
no-load fund in 1928. Perhaps the biggest advancement would come from the creation
of the Wellington Fund. Wellington—which is now part of Vanguard—was the first
mutual fund to own stocks and bonds in one ticker. By the end of 1929, there were 19
open-ended mutual funds and roughly 700 closed-end funds in the U.S.

But all good things must come to an end. The stock market crash of 1929 and
resulting Great Depression put the kibosh on the mutual fund industry. That is until
the creation of the Securities and Exchange Commission (SEC), the passage of the
Securities Act of 1933, and the enactment of the Securities Exchange Act of 1934.
These events saw several important safeguards designed to protect investors put in
place, including quarterly filings with the SEC as well as requiring that a prospectus
be made available for investors.

Modern Times: Index Funds, IRAs & ETFs

The mutual fund industry really got cooking after World War II ended and America
began to boom during the 1950s. By 1951, there were more than 100 mutual funds
operating and more than 150 additional funds were created over the next two decades.
The 1960s saw the birth of aggressive growth funds, which bet on high tech stocks,
while the 1970s and 1980s saw some of the biggest contributions to mutual funds’
history.
One of the biggest contributions was the creation of the index fund – a mutual fund
that would hold all the stocks of a particular market measure. William Fouse and John
McQuown of Wells Fargo established the first index fund in 1971. However, it was
Vanguard’s John Bogle who made it memorable back in 1974 by offering it to retail

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investors. The First Index Investment Trust—based on the S&P 500 Index—allowed
Mom & Pop investors to own the entire market. The first money market fund—The
Reserve Fund—debuted in 1971, while 1976 saw the first municipal bond launch. The
1990s saw the rise of the superstar fund manager, as people like Bill Miller and Peter
Lynch became driving forces at the funds they managed.

Powering the expansion of mutual funds during this time had been the creation of
various retirement and tax vehicles such as the IRA and 401(K) accounts. These
accounts helped to replace traditional pensions at many companies. As such, money
from investors of all sizes and walks of life poured directly into mutual funds.

Today, the evolution of mutual funds continues with the creation of the exchange
traded fund (ETF). In 1993, Nathan Most developed a way for investors to trade index
funds throughout the day. He dubbed his fund the Standard & Poor’s Depository
Receipts (SPDRs -pronounced spiders) and based it off the S&P 500 Index.
The SPDR S&P 500 (SPY) kicked off the ETF revolution and is still one of the most
successful funds.

The Bottom Line

With more than 14,000 mutual funds available to investors today, it just goes to show
how successful the idea of pooling small amounts of capital to own stocks and bonds
can be. Mutual funds continue to evolve and will continue to be a major backbone in
how retail investors build wealth. We all owe Abraham van Ketwich as well as the
other early innovators a bit of gratitude.

The Mutual Fund Industry in India:

The mutual fund industry in India started in 1963 with the formation of Unit Trust of
India (UTI) at the initiative of the Reserve Bank of India (RBI) and the Government
of India. The objective then was to attract small investors and introduce them to
market investments. Since then, the history of mutual funds in India can be broadly
divided into six distinct phases.

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Phase Year Events
1 1964-1987 Growth Of UTI
2 1987-1993 Entry of Public Sector Funds
3 1993-1996 Emergence of Private Funds
4 1996-1999 Growth And SEBI Regulation
5 1999-2004 Emergence of a Large and Uniform Industry
6 2004 onwards Consolidation and Growth

Phase I (1964-87): Growth of UTI:

In 1963, UTI was established by an Act of Parliament. As it was the only entity
offering mutual funds in India, it had a monopoly. Operationally, UTI was set up by
the Reserve Bank of India (RBI), but was later delinked from the RBI. The first
scheme, and for long one of the largest launched by UTI, was Unit Scheme 1964.

Later in the 1970s and 80s, UTI started innovating and offering different schemes to
suit the needs of different classes of investors. Unit Linked Insurance Plan (ULIP)
was launched in 1971. The first Indian offshore fund, India Fund was launched in
August 1986. In absolute terms, the investible funds corpus of UTI was about Rs 600
crores in 1984. By 1987-88, the assets under management (AUM) of UTI had grown
10 times to Rs 6,700 crores.

Phase II (1987-93): Entry of Public Sector Funds:

The year 1987 marked the entry of other public sector mutual funds. With the opening
up of the economy, many public sector banks and institutions were allowed to
establish mutual funds. The State Bank of India established the first non-UTI Mutual
Fund, SBI Mutual Fund in November 1987. This was followed by Canbank Mutual
Fund, LIC Mutual Fund, Indian Bank Mutual Fund, Bank of India Mutual Fund, GIC
Mutual Fund and PNB Mutual Fund. From 1987-88 to 1992-93, the AUM increased
from Rs. 6,700 crores to Rs. 47,004 crores, nearly seven times. During this period,
investors showed a marked interest in mutual funds, allocating a larger part of their
savings to investments in the funds.

Phase III (1993-96): Emergence of Private Funds:

A new era in the mutual fund industry began in 1993 with the permission granted for
the entry of private sector funds. This gave the Indian investors a broader choice of
'fund families' and increasing competition to the existing public sector funds. Quite

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significantly foreign fund management companies were also allowed to operate
mutual funds, most of them coming into India through their joint ventures with Indian
promoters.
The private funds have brought in with them latest product innovations, investment
management techniques and investor-servicing technologies. During the year 1993-
94, five private sector fund houses launched their schemes followed by six others in
1994-1995.

Phase IV (1996-99): Growth and SEBI Regulation:

Since 1996, the mutual fund industry scaled newer heights in terms of mobilization of
funds and number of players. Deregulation and liberalization of the Indian economy
had introduced competition and provided impetus to the growth of the industry.
A comprehensive set of regulations for all mutual funds operating in India was
introduced with SEBI (Mutual Fund) Regulations, 1996. These regulations set
uniform standards for all funds. Erstwhile UTI voluntarily adopted SEBI guidelines
for its new schemes. Similarly, the budget of the Union government in 1999 took a
big step in exempting all mutual fund dividends from income tax in the hands of the
investors. During this phase, both SEBI and Association of Mutual Funds of India
(AMFI) launched Investor Awareness Programme aimed at educating the investors
about investing through MFs.

Phase V (1999-2004): Emergence of a Large and Uniform Industry:

The year 1999 marked the beginning of a new phase in the history of the mutual fund
industry in India, a phase of significant growth in terms of both amount mobilized
from investors and assets under management. In February 2003, the UTI Act was
repealed. UTI no longer has a special legal status as a trust established by an act of
Parliament. Instead it has adopted the same structure as any other fund in India - a
trust and an AMC.

UTI Mutual Fund is the present name of the erstwhile Unit Trust of India (UTI).
While UTI functioned under a separate law of the Indian Parliament earlier, UTI
Mutual Fund is now under the SEBI's (Mutual Funds) Regulations, 1996 like all other
mutual funds in India.

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The emergence of a uniform industry with the same structure, operations and
regulations make it easier for distributors and investors to deal with any fund house.
Between 1999 and 2005 the size of the industry has doubled in terms of AUM which
has gone from above Rs 68,000 crores to over Rs 1,50,000 crores.

Phase VI (From 2004 Onwards): Consolidation and Growth:

The industry has lately witnessed a spate of mergers and acquisitions, most recent
ones being the acquisition of schemes of Allianz Mutual Fund by Birla Sun Life, PNB
Mutual Fund by Principal, among others. At the same time, more international players
continue to enter India including Fidelity, one of the largest funds in the world.

1.6 ADVANTAGES and DISADVANTAGES OF MUTUAL FUNDS:

 Advantages of Mutual Funds:
Mutual fund investments in stocks, bonds and other instruments require considerable
expertise and constant supervision, to allow an investor to take the right decisions.
Small investors usually do not have the necessary expertise and time to undertake any
study that can facilitate informed decisions. While this is the predominant reason for
the popularity of mutual funds, there are many other benefits that make mutual funds
appealing.
1. Diversification Benefits:
Diversified investment improves the risk return profile of the portfolio. Optimal
diversification has limitations due to low liquidity among small investors. The large
corpus of a mutual fund as compared to individual investments makes optimal
diversification possible. Due to the pooling of capital, individual investors can derive
benefits of diversification.

2. Low Transaction Costs:

Mutual fund transactions are generally very large. These large volumes attract lower
brokerage commissions and other costs as compared to smaller volumes of the
transactions that individual investors enter into. The brokers quote a lower rate of
commission due to two reasons. The first is competition for the institutional investors
business. The second reason is that the overhead cost of executing a trade does not
differ much for large and small orders. Hence for a large order these costs spread over
a large volume enabling the broker to quote a lower commission rate.

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 3. Availability of Various Schemes:
There are four basic types of mutual funds: equity, bond, hybrid and money market.
Equity funds concentrate their investments in stocks. Similarly bond funds primarily
invest in bonds and other securities. Equity, bond and hybrid funds are called long-
term funds. Money market funds are referred to as short-term funds because they
invest in securities that generally mature in about one year or less. Mutual funds
generally offer a number of schemes to suit the requirement of the investors.

4. Professional Management:
Management of a portfolio involves continuous monitoring of various securities and
innumerable economic variables that may affect a portfolio's performance. This
requires a lot of time and effort on part of the investors along with in-depth
knowledge of the functioning of the financial markets. Mutual funds are managed by
fund managers generally with knowledge and experience whose time is solely
devoted to tracking and updating the portfolio. Thus investment in a mutual fund not
only saves time and effort for the investor but is also likely to produce better results.

5. Liquidity:
Liquidating a portfolio is not always easy. There may not be a liquid market for all
securities held. In case only a part of the portfolio is required to be liquidated, it may
not be possible to see all the securities forming a part of the portfolio in the same
proportion as they are represented in the portfolio; investing in mutual funds can solve
these problems. A fund house generally stands ready to buy and sell its units on a
regular basis. Thus it is easier to liquidate holdings in a Mutual Fund as compared to
direct investment in securities.

6. Returns:
In India dividend received by investors is tax-free. This enhances the yield on mutual
funds marginally as compared to income from other investment options. Also in case
of long-term capital gains, the investor benefits from indexation and lower capital
gain tax.

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 7. Flexibility:
Features of a MF scheme such as regular investment plan, regular withdrawal plans
and dividend reinvestment plan allows investors to systematically invest or withdraw
funds according to the needs and convenience.

8. Well Regulated:
All mutual funds are registered with SEBI and they function within the provisions of
strict regulations designed to protect the interest of investors. The SEBI regularly
monitors the operations of an AMC.

 Disadvantages of Mutual Fund

Investment in mutual funds has its disadvantages as well.
1. The investors cannot choose the securities they want to invest in, or the
securities they want to sell.
2. The investors face the risk of the fund manager not performing well. Also, the
fund manager's compensation is linked to the fund's performance; he may be
tempted to show good results in the short-term without paying attention to the
expected long-term performance of the fund. This would harm the long-term
interests of the investor.
3. The management fees charged by the fund. It reduces the returns available to
the investors.
4. While investors in securities can decide the amount of earnings they want to
withdraw in a particular period, investors in a mutual fund have no such
discretion as the amount of earnings that are to be paid out to the investors in a
particular year is decided by the mutual fund.

The predominant reason for the popularity of mutual funds is that small investors
usually do not have the necessary expertise and the time to undertake any study that
can facilitate informed decision. Because investments in stocks, bonds and other
financial instruments require considerable expertise and constant supervision, to
enable an investor to take informed decision. The above stated are some of the
advantages and disadvantages of investment in mutual funds.

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